Getco LLC, the closely held high- frequency trading company that negotiated a takeover of Knight Capital Group Inc (KCG:US). in December, said profit plunged last year as stock-market volume dropped and volatility evaporated.
Net income fell 82 percent to $24.6 million in the nine months ended Sept. 30, compared with $134.8 million a year ago, according to a filing today. Revenue decreased 41 percent to $425.3 million. Getco agreed to buy Knight in a $1.4 billion deal after the market maker lost more than $450 million when computers generated a flood of erroneous orders in August.
“When economic activities are low and volumes are low and volatility is low, it’s a bad recipe,” Christopher Allen, an analyst at Evercore Partners Inc (EVR:US). in New York, said in a phone interview. “You look at trading revenues broadly, they’ve been challenged.”
Getco’s disclosure is one of the first to detail its financial health as the company prepares to issue stock as part of the Knight acquisition. The filing may help clarify the value of the Knight takeover since one-third of the price is represented by newly issued Getco stock for which there hadn’t previously been a public market. The new company will be called KCG for Knight Capital Getco.
In accepting the bid, directors of the Jersey City, New Jersey-based trading firm spurned an all-cash offer from Virtu Financial LLC, another high-frequency trader, which argued that its bid was superior because it wasn’t subject to the uncertainty of the stock market.
Knight’s stock rose (KCG:US) 2 cents to $3.72 at the close of trading in New York. It plunged from a 2012 high of $13.53 to $2.36 on Nov. 15, 2012, and hasn’t traded above $4 since early August. Getco offered $3.75 a share for Knight, one-third of it in stock, for a total value of $1.4 billion, according to a Dec. 19 statement from Knight.
“The trading price of a share of KCG common stock is currently uncertain and we can provide no assurance as to the values at which shares of KCG will publicly trade,” Getco said in the filing. “Although shares of Knight are currently listed for trading on the NYSE, units of Getco are not listed for trading on a national securities exchange and Getco has not been subject to the reporting requirements of the Exchange Act.”
The filing shows plunging volume and volatility last year spurred a deterioration in Getco’s primary business of making markets on equity exchanges and other venues through automated, high-speed programs. The company’s revenue from market making, which represents almost 94 percent of the total, fell 44 percent during the first nine months of 2012.
The Chicago Board Options Exchange Volatility Index, known as the VIX, has declined 32 percent during the past 12 months, reaching a five-year low in January.
Average daily volume for stocks listed on U.S. exchanges has declined every year since 2009, falling 18 percent in 2012 to a low of 6.42 billion shares, according to data compiled by Bloomberg. That compares with 9.77 billion in 2009 and 6.36 billion so far in 2013.
Chicago-based Getco’s annual revenue was $915.5 million in 2011, $866.9 million in 2010 and $956.8 million in 2009, according to the filing. About 68 percent of Getco’s trading revenue came from equities, compared with 21 percent from fixed income and 11 percent from commodities and foreign exchange in the nine months ended Sept. 30, it said.
Most of Getco’s market-making revenue is from high- frequency strategies with short-term risks and little overnight exposure to price moves. The company is now building a “mid- frequency” market-making business that will depend less on trading volume and involve positions being held for at least several days, the filing said.
Getco spent $36.8 million in the first nine months of 2012 to develop trading strategies in its options, global arbitrage, mid-frequency and execution-services businesses, the filing said. Its staff increased to 409 employees at the end of the period, compared with 372 a year earlier. Knight had 1,524 employees at the end of last year.
The expanded businesses probably haven’t yet added meaningfully to revenue, Richard Repetto, an analyst at Sandler O’Neill & Partners LP, said in a report today. Getco’s adjusted net income for the first three quarters of 2012, after adding back that investment, was $60.3 million, down 55 percent from the year-earlier period, he wrote.
Revenue from high-frequency stock trading may increase by about 22 percent to $2.2 billion in 2013 as volume in U.S. equity markets rebounds following a three-year slump, according to Tabb Group LLC. With rivals consolidating or ceasing operations in some regions or asset classes, Getco said it may be able to extend its market share when volume and volatility increase, according to the filing.
“Market making across the board has been under pressure for the last couple of years,” Adam Sussman, director of research at Tabb, said in a phone interview. “There was more supply than demand. We’re seeing that rationalize now through consolidation. This was a low point, and through consolidation and modest recovery, the prospects will be better.”
Trading volume may increase by 6 percent this year after declining from 2010 to 2012, Sussman predicted in a January report. High-frequency trading revenue reached $7.2 billion at its peak in 2009 before declining to $1.8 billion in 2012, the report said.
The merger combines the technology and operations of Getco with Knight’s customer-servicing business. Knight, which as a wholesaler executes orders from individual investors sent to it by about 700 retail brokers, provides access to markets and execution services to about 650 brokerages and 1,500 institutional clients, the filing said. It runs platforms to trade bonds, foreign currency pairs and precious metals.
Cost savings in the combined company will come from “redundancy eliminations” in technology infrastructure, employee and professional fees, the filing said. Increased revenue may result from better trading strategies and higher rebates from exchanges and other venues for supplying liquidity.
Knight’s computers accidentally bombarded U.S. equity exchanges with share orders in August, spurring a trading loss of more than $450 million and eventually a bailout by six financial firms including Getco and investment bank Jefferies Group Inc. (JEF:US)
“Knight and Getco have created an integration planning framework,” the companies said in the filing today. “There is a high-level shared acknowledgment at both companies that key priorities for the integration include mitigating operational risk and seamlessly integrating all necessary risk controls.”
Knight said earlier this month that it would cut 5 percent of its workforce as it combines sales teams and discontinues its clearing business. The company reported an 84 percent decline in fourth-quarter earnings (KCG:US) after trading slowed and stock-price swings narrowed.
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